Year-End Tax Planning for Individuals

The Tax Cuts and Jobs Act introduced over 130 new provisions affecting both individuals and businesses alike. As we transition into year-end tax planning, our attention turns to helping clients optimize their tax positions in the midst of unprecedented change.

Passed in December 2017, the tax reform bill contains a number of individual tax breaks that are set to expire in Dec. 31, 2025, many of them taking effect this year.

The Change in Deductions – Standard vs. ItemizedThe good news is that the standard deduction in 2018 nearly doubles from $6,350 to $12,000 for single filers and $12,700 to $24,000 for married individuals filing jointly. And in many cases, the 2018 tax rates for income levels are lowered or remain the same as in 2017.

The not-so-good news is that personal exemption deductions and many itemized deductions are suspended or eliminated.

For many taxpayers, these changes translate into preparing simpler returns and paying less tax. Taxpayers who continue to itemize, however, will see the following changes:

State and local income tax, sales, and real and personal property (SALT) are capped at $10,000.

Prepaid Property Taxes: If a taxpayer prepaid their 2018 state or local real property taxes in 2017 and they were assessed by local jurisdiction prior to 2018, the IRS will allow the higher deduction. The tax reform bill clearly states, however, prepayment of state income tax is prohibited.

Evaluate Primary Residence: Some taxpayers may experience a significant tax impact by the new SALT cap. If you are close to or in retirement, have you considered changing your primary residence to a state with a lower tax burden? Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming currently do not have income tax.

Year-end tax planning will evaluate all angles of your tax situation and leverage other favorable tax reform changes in an effort to offset the SALT cap.

Home mortgage interest deduction is limited to home acquisition debt (for up to two homes) up to $750,000, or $375,000 for married individual filing separately, for loans obtained after Dec. 15, 2017 through 2025. Existing mortgages are grandfathered in based on the prior $1 million cap.

Home equity loan interest deduction is generally disallowed under the tax reform bill. However, the IRS clarified that taxpayers may continue to deduct the interest paid on home equity loans and lines of credit provided that the funds are used to buy, construct or improve the taxpayer’s residence. Please note that this deduction is subject to the overall $750,000/$375,000 limit on home acquisition debt, and anything in excess is no longer deductible.

Medical expenses that exceed 7.5 percent of your adjusted gross income (AGI) may be deductible for 2017 and 2018 tax years. In 2019, however, the floor increases to 10 percent. It may be advantageous to schedule optional medical procedures in 2018 if it will lead to an increased deduction.

The charitable contribution limit on cash donations to public nonprofits and certain private foundations is increased from 50 percent to 60 percent of AGI. A tax planning strategy to take advantage of this increased limit is to bunch or increase charitable contributions over multiyear periods. Establishing a donor-advised fund (DAF) is a planning strategy to combine multiple years worth of charitable contributions into one larger deduction, allowing taxpayers to claim a deduction in the funding year at a higher tax rate, while scheduling grants to be allocated over two or more years. In addition, taxpayers can gift those appreciated assets held for over a year and take a deduction for the full market value of the gift in the year it’s allocated, avoiding capital gains taxes on the gifted securities.

Casualty and theft losses are only deductible for presidentially-declared disaster areas.

Miscellaneous itemized deductions for individuals have been repealed, which includes expenses such as asset management fees and unreimbursed employee expenses. If the employer pays for or reimburses employee expenses (often referred to as working condition fringe benefits), they will continue to be tax-free to the employee. Individuals with considerable unreimbursed employee expenses, including mileage, education costs, etc., should request an excludable working condition fringe benefit arrangement or accountable plan from their employer. Several fringe benefits that can continue to be provided tax-free to an employee will no longer be tax deductible by the employer.

Alternative Minimum Tax ReliefThe alternative minimum tax (AMT) exemption levels and income thresholds were raised and will provide relief to counteract the new limits surrounding itemized deductions, such as the SALT cap.

Under previous law, AMT exemption amounts in 2017 were $54,300 for individuals and $84,500 for married individuals filing a joint return. Now, under current law, the exemption amounts are $70,300 for individuals and $109,400 for couples.

Income thresholds are significantly increased from $120,700 for individuals and $160,900 for married individuals filing jointly to $500,000 for individuals and $1 million for married individuals filing jointly.

Exemptions Doubled for Estate and Gift TaxAlthough the estate tax remains, the increase in exemption amounts for the estate, gift, and generation-skipping tax presents a ripe opportunity for year-end tax planning. The exemption amounts are now doubled from $5.6 million to $11.2 million ($22.4 million for couples). In addition, the tax basis step-up rules to fair market value as of the date of death continue to apply under the reform bill. As similar to previous law, a 40 percent tax rate will affect transfers exceeding this amount.

These exemption amounts are set to expire at the end of 2025 and revert back to 2017 levels, so it is important to consider making gifts and setting up irrevocable trusts during this timeframe when exemption amounts are favorable.

The annual gift tax exclusion also increases in 2018 to $15,000 ($30,000 for couples) due to inflation.

Qualified Tuition Plans ExpandedA popular savings vehicle when planning for education expenses is the qualified tuition plan, also known as the 529 college savings plan. The tax reform bill expanded the treatment of 529 plans, as under previous law, the funds accrued in a 529 plan could be withdrawn tax-free only if used for higher education at universities, colleges, vocational schools or other post-secondary schools.

Under current law, up to $10,000 annually can be withdrawn from a 529 plan and used to pay for tuition at an elementary or secondary public, private or religious school. If you are currently paying for tuition at an elementary or secondary school, it may be advantageous to revisit your investment strategy as year-end tax planning strategies are considered.

Child Tax Credit DoubledThe Child Tax Credit is doubled to $2,000 per qualifying child under the 2018 tax reform, with a refundable amount limited to $1,400. After 2018, the credit amount will be adjusted for inflation.

Alimony Deductions ImpactedAs of January 1, 2018, the tax code on alimony will change for those filing for divorce or separation. The new law eliminates alimony deductions for the payor and does not require the payee to report the alimony payments as taxable income. This change shifts the tax burden from the payor to the payee. Under previous law, the payor of alimony could deduct the full payment amount from their annual earnings. The payee was then required to claim the alimony and add it to their income.

Please note that if you are currently paying or receiving alimony, the changes contained in this notice will not affect you. Tax deductions on existing alimony agreements will be upheld by the IRS. Be advised, however, if you make any modifications to the alimony agreement after December 31, 2018, the new alimony rules may potentially affect your situation. You should consider seeking legal and tax advice regarding tax treatment of any modifications before signing off on the changes.

Traditional Tax Planning StrategiesThe abovementioned changes are plentiful and will take some planning efforts to ensure compliance and favorable outcomes. In addition to the reform bill changes, there are always the tried-and-true tax planning strategies to consider each year.

The following strategies should be considered in tandem with tax reform changes.

Timing of Income and DeductionsIf you are not subject to Alternative Minimum Tax (AMT) this year or next, deferring income and accelerating deductions will reduce taxable income and potentially reduce your taxes. Deferring income also may help minimize or avoid AGI-based (adjusted gross income) phaseouts of various tax breaks that are applicable for 2018. If you have a unique situation, however, some taxpayers may benefit from applying the opposite approach by accelerating income and deferring deductions. Discussing these options with your advisor is recommended to achieve the best possible results.

Retirement ContributionsBy contributing the maximum allowable amount to your retirement plan, you will not only reduce your tax burden this year, but you will also defer taxes until later in life when you will most likely be in a lower tax bracket. Leveraging employer contributions or matching opportunities will also help your retirement fund grow more quickly.

Energy Tax IncentivesIf you made energy-saving solar property upgrades this year, or plan to, you may be able to claim tax credits. Gradual phaseouts apply before 2022.

The clock is ticking for Tesla buyers, as the automaker officially delivered its 200,000 car in July, which means Tesla’s electric vehicle tax credit is nearing its end. The gradual 18-month phaseout has begun. Tesla buyers who take delivery of their cars between now and December 31, 2018 may be able to receive the full $7,500 tax credit on their returns. For vehicles delivered between January 1, 2019 and June 30, 2019, customers will be eligible for a $3,750 credit. And a credit of only $1,875 will be eligible for buyers who take delivery between July 1, 2019 and December 31, 2019. After next year, the incentive has completely phased out and will be no longer available.

Onward and UpwardAs we consider all of the above changes to the federal tax code, we also need to be mindful that many states, including California, did not conform to all or part of the Tax Cuts and Jobs Act. Therefore, certain deductions that were eliminated for federal purposes are still available on state returns, and income items that may not be federally taxable are included in state taxable income. A blended look at both federal and state tax law is therefore needed to guide current planning.

With the recent overhaul of the tax code, it is important to consider your tax position and uncover optimal year-end tax planning strategies. Please contact me at bforeman@bpw.com or (805) 963-7811 if you have any questions.